Posted by: Peter Coy on November 16, 2007

This is the B side of the blog item I wrote a few days ago, called Suddenly everybody loves Fannie and Freddie. In that item, I worried that Congress was underestimating the risks facing Fannie Mae and Freddie Mac. Well, maybe Congress is still in Fannie and Freddie’s camp, but investors are getting much less so.

Credit to a competitor: Writing for Fortune.com yesterday, Fortune magazine senior writer Peter Eavis pointed out that Fannie Mae has changed its accounting in a way that could mask some of its credit losses. Fannie Mae called a news conference today to explain its side of the story but investors weren’t entirely persuaded, judging by the stock’s performance. Shares fell $4.78 on Thursday and $2.35 today for a two-day decline of 15% and a decline since mid-October of close to 30%.

I listened to the conference call and didn’t get much out of it, either. You can listen it to yourself, if you have a lot of patience, at www.fanniemae.com. Most of the analysts who called in were excruciatingly polite to the Fannie Mae speakers, but one expressed his annoyance: “I would point out to you that your stock is down 25% since the earnings call. … To be honest with you, this isn’t very helpful.”

Reader Comments

Brian R

November 16, 2007 11:12 PM

My vehement opposition to a taxpayer-funded bailout of home borrowers, whether subprime or otherwise, includes opposition to any near-term increase in the portfolios or loan limits of Fannie Mae or Freddie Mac.

As Senator Charles Schumer was quoted recently on bloomberg.com, “Because the regular markets aren’t giving these people [subprime borrowers] money, the obvious place is Fannie and Freddie.” So, the subprime borrowers are in default, their credit was already poor, their homes are worth less than the balance owing on their mortgages, and the solution proposed by Senator Schumer is to require that Fannie Mae and Freddie Mac refinance these now soured loans. Brilliant. So what if a demonstrable percentage of the borrowers would default on any new loans, just as they have already done on their current ones. The taxpayer would be there to pick up the tab. (Is it any wonder that Congressional ratings are so poor?)

Fannie Mae is losing too much money as it is. According to an article last week on bloomberg.com, “Fannie Mae, the biggest source of money for U.S. home loans, said its third-quarter loss more than doubled to $1.39 billion as a deepening housing slump increased mortgage delinquencies.” Further, according to CEO Daniel Mudd, “The loan loss ratio could at least double to 8 to 10 basis points next year.”

Worse yet, according to a news article this week (also on bloomberg.com):

‘Subprime borrowers are likely to default on 30 percent to 40 percent of debt,’ [Deutsche’s Bank credit-analyst Mike] Mayo wrote. ‘Losses on loans to people with poor credit histories may be as much as half the sum lent. Banks and brokers may have to write off $60 billion to $70 billion this year,’ Mayo wrote. [Emphasis added.]

As that same article quoted analysts at Lehman Brothers, “ Commercial banks, government-chartered firms Fannie Mae and Freddie Mac, and mortgage bond insurers will be affected the most by mortgage losses, which will be about $50 billion in 2008.” [Emphasis added.]

In light of the above, Senator Schumer’s intent that portfolio limits at Fannie Mae and Freddie Mac be increased by a total of $150 billion, with 85 percent of that $150 billion to be used to refinance subprime loans, is stunningly misguided. As in, like a missile firing backward.

If there were ever a time for Fannie Mae and Freddie Mac to be buying more mortgage loans, this is not it. More specifically, the idea of buying more subprime loans now is worse than irresponsible. Increasing the portfolio limits of the GSE’s (Fannie and Freddie) would simply throw more billions of dollars down the rathole. Granted, the federal government not infrequently throws billions of dollars down that rathole, but with such major ongoing costs as Medicare and the war in Iraq, fiscal discipline has become even more essential.

As to the interests of Wall Street, all concerned can appreciate the importance of that district’s remaining healthy. Even with the recently announced losses due to poor lending practices, however, Wall Street will continue to do just fine. According to another article this week, “Even after the record $8.4 billion writedown for bad debts at Merrill Lynch & Co., the unprecedented ouster of three chief executives within five months and the elimination of $84 billion of market value at the five largest securities firms, Wall Street still is poised to report its second-most profitable year ever. And 2008 may be better [yet].” [Emphasis added.] So, no one in the governmental sector should be shedding tears over conditions on Wall Street.

As to talk of increasing the loan limits of Fannie and Freddie, that, too, would be a major mistake. Housing costs in many areas of the country became exorbitant in large part because lenders were handing out those idiotic mortgages, especially the teaser-rate and option ARM varieties. Those mortgages enabled borrowers to borrow more than they could pay back. (My brother Mike, a long-time Realtor in northern Virginia, refers to those mortgages as “neutron” mortgages: they kill the owner, but leave the house standing.)

Recently, Walter Hahn, a long-time real estate market watcher in southern California, explained to the Orange County Register how he himself was so wrong in predicting that the median price would continue to skyrocket:

Along with almost everyone else, I didn’t recognize that the 2003 thru mid-2006 housing market boom was caused almost exclusively by the introduction (and pushing) of low-teaser-rate loans. Also, the explosion of those loans wouldn’t have happened if the wise guys on Wall Street hadn’t provided the money to fund the loans by packaging the loans to support financial instruments that they sold to bigger suckers.

In retrospect this was a house of pure greed built on quicksand bound to collapse when the millions of home loan borrowers couldn’t make their payments when the loans reset and the payments jumped 3 to 5 times.

[Register:] What was it you didn’t foresee? Where did the demand go?
Walter: Shame on me! After 40 years of analyzing my way through four economic and housing market booms and busts, I knew that the fuel for every boom also eventually burns it up and causes it to go bust. I had my head in the sand and wasn’t paying attention. If I had been paying attention I would have known that a high percentage of those low-teaser-rate loans would go into foreclosure and bring the whole house of greed tumbling down. But I wasn’t paying attention.
[Register:] How brutal will a recession be on borrowers?

Walter: The housing market recession has already been brutal on aggressive borrowers and the unsuspecting borrowers who were conned into low teaser rate loans. That brutality will continue for another 2 to 3 years until all the resets and foreclosures are recycled through the market.

[Register:] What lessons have you learned from this?

Walter: I should have had my head out of the sand and been conscious of the fact, which I knew, that every boom has its bust, and I should have analyzed this one to figure out the boom’s cause and when and how it was likely to self-destruct. I just wasn’t paying attention....

As to yet another “expert,” one who still has not figured out why the high prices are finally adjusting (albeit they have a long way to go), consider Robert Rivinius, CEO of the California Building Industry Association. Mr. Rivinius was quoted recently in the San Diego Union-Tribune as follows:

‘Homeownership in California is only 56 percent, [while homeownership in] the rest of the nation is 69 percent,’ Rivinius said. ‘So the homeownership rate [in California] is lower than (that of) the rest of the country, and if we don’t raise the [GSE’s loan] limit, things will never improve.’

Mr. Rivinius has yet to discern that the reason why the homeownership rate in California is lower than elsewhere is because prices in California are higher than elsewhere. Further, prices are higher in California than elsewhere due in large part to the unusually large number of toxic mortgages in his state. Without those toxic mortgages, prices could not have escalated to the unsustainable heights which they did. And, as with many other areas of the country, prices in California remain out of whack with incomes.

If Congress were to raise the GSE’s loan limits, such a move would pump yet more air into the still-inflated housing bubble, and therefore postpone the inevitable market correction. If Fannie and Freddie can insure and buy more expensive loans, lenders in California, and elsewhere, will find a way to squeeze even more unqualified buyers into those loans. Worse, unlike the situation with the existing loans which are now in default, once the buyers were to have defaulted on the new loans, the federal taxpayer would be obligated to pick up the tab.

Finally, consider one of the hardest hit markets, that of Cleveland’s. The following is an excerpt from an article this week (on CNNMoney.com):

But even the staunchly pro-consumer [Cuyahoga County Treasurer Jim] Rokakis admitted that predatory lending victims are not entirely blameless for their own problems. With times hard, ‘People were looking for a way to make a living,’ he said. ‘There were all these 'Buy real estate with no credit and no down payment deals. The way to wealth was real estate. Speculation took off, and expectations ran wild before they were dashed.’

As the article adds,

According to Mark Seifert, executive director of [Cleveland’s] East Side Organizing Project, which provides foreclosure prevention services, his staff used to look out the window just before groups of troubled home owners were due in to attend counseling sessions. ‘We'd see Escalades, Range Rovers, Cadillacs out in the parking lots,’ he said. [Emphasis added.]

The article adds further:

Now Rokakis's office is dealing with the aftermath. [According to Rokakis,] ‘One guy came in wanting [our office’s] help to save 12 separate properties,’ many of which he bought on speculation, entirely on credit with none of his own cash invested.’

Please join me in informing our representatives in Washington, D.C., including President Bush, that we give an emphatic “thumbs down” to any bailout. We cannot afford to throw good money after bad.

Brian R

November 16, 2007 11:13 PM

My vehement opposition to a taxpayer-funded bailout of home borrowers, whether subprime or otherwise, includes opposition to any near-term increase in the portfolios or loan limits of Fannie Mae or Freddie Mac.

As Senator Charles Schumer was quoted recently on bloomberg.com, “Because the regular markets aren’t giving these people [subprime borrowers] money, the obvious place is Fannie and Freddie.” So, the subprime borrowers are in default, their credit was already poor, their homes are worth less than the balance owing on their mortgages, and the solution proposed by Senator Schumer is to require that Fannie Mae and Freddie Mac refinance these now soured loans. Brilliant. So what if a demonstrable percentage of the borrowers would default on any new loans, just as they have already done on their current ones. The taxpayer would be there to pick up the tab. (Is it any wonder that Congressional ratings are so poor?)

Fannie Mae is losing too much money as it is. According to an article last week on bloomberg.com, “Fannie Mae, the biggest source of money for U.S. home loans, said its third-quarter loss more than doubled to $1.39 billion as a deepening housing slump increased mortgage delinquencies.” Further, according to CEO Daniel Mudd, “The loan loss ratio could at least double to 8 to 10 basis points next year.”

Worse yet, according to a news article this week (also on bloomberg.com):

‘Subprime borrowers are likely to default on 30 percent to 40 percent of debt,’ [Deutsche’s Bank credit-analyst Mike] Mayo wrote. ‘Losses on loans to people with poor credit histories may be as much as half the sum lent. Banks and brokers may have to write off $60 billion to $70 billion this year,’ Mayo wrote. [Emphasis added.]

As that same article quoted analysts at Lehman Brothers, “ Commercial banks, government-chartered firms Fannie Mae and Freddie Mac, and mortgage bond insurers will be affected the most by mortgage losses, which will be about $50 billion in 2008.” [Emphasis added.]

In light of the above, Senator Schumer’s intent that portfolio limits at Fannie Mae and Freddie Mac be increased by a total of $150 billion, with 85 percent of that $150 billion to be used to refinance subprime loans, is stunningly misguided. As in, like a missile firing backward.

If there were ever a time for Fannie Mae and Freddie Mac to be buying more mortgage loans, this is not it. More specifically, the idea of buying more subprime loans now is worse than irresponsible. Increasing the portfolio limits of the GSE’s (Fannie and Freddie) would simply throw more billions of dollars down the rathole. Granted, the federal government not infrequently throws billions of dollars down that rathole, but with such major ongoing costs as Medicare and the war in Iraq, fiscal discipline has become even more essential.

As to the interests of Wall Street, all concerned can appreciate the importance of that district’s remaining healthy. Even with the recently announced losses due to poor lending practices, however, Wall Street will continue to do just fine. According to another article this week, “Even after the record $8.4 billion writedown for bad debts at Merrill Lynch & Co., the unprecedented ouster of three chief executives within five months and the elimination of $84 billion of market value at the five largest securities firms, Wall Street still is poised to report its second-most profitable year ever. And 2008 may be better [yet].” [Emphasis added.] So, no one in the governmental sector should be shedding tears over conditions on Wall Street.

As to talk of increasing the loan limits of Fannie and Freddie, that, too, would be a major mistake. Housing costs in many areas of the country became exorbitant in large part because lenders were handing out those idiotic mortgages, especially the teaser-rate and option ARM varieties. Those mortgages enabled borrowers to borrow more than they could pay back. (My brother Mike, a long-time Realtor in northern Virginia, refers to those mortgages as “neutron” mortgages: they kill the owner, but leave the house standing.)

Recently, Walter Hahn, a long-time real estate market watcher in southern California, explained to the Orange County Register how he himself was so wrong in predicting that the median price would continue to skyrocket:

Along with almost everyone else, I didn’t recognize that the 2003 thru mid-2006 housing market boom was caused almost exclusively by the introduction (and pushing) of low-teaser-rate loans. Also, the explosion of those loans wouldn’t have happened if the wise guys on Wall Street hadn’t provided the money to fund the loans by packaging the loans to support financial instruments that they sold to bigger suckers.

In retrospect this was a house of pure greed built on quicksand bound to collapse when the millions of home loan borrowers couldn’t make their payments when the loans reset and the payments jumped 3 to 5 times.

[Register:] What was it you didn’t foresee? Where did the demand go?
Walter: Shame on me! After 40 years of analyzing my way through four economic and housing market booms and busts, I knew that the fuel for every boom also eventually burns it up and causes it to go bust. I had my head in the sand and wasn’t paying attention. If I had been paying attention I would have known that a high percentage of those low-teaser-rate loans would go into foreclosure and bring the whole house of greed tumbling down. But I wasn’t paying attention.
[Register:] How brutal will a recession be on borrowers?

Walter: The housing market recession has already been brutal on aggressive borrowers and the unsuspecting borrowers who were conned into low teaser rate loans. That brutality will continue for another 2 to 3 years until all the resets and foreclosures are recycled through the market.

[Register:] What lessons have you learned from this?

Walter: I should have had my head out of the sand and been conscious of the fact, which I knew, that every boom has its bust, and I should have analyzed this one to figure out the boom’s cause and when and how it was likely to self-destruct. I just wasn’t paying attention....

As to yet another “expert,” one who still has not figured out why the high prices are finally adjusting (albeit they have a long way to go), consider Robert Rivinius, CEO of the California Building Industry Association. Mr. Rivinius was quoted recently in the San Diego Union-Tribune as follows:

‘Homeownership in California is only 56 percent, [while homeownership in] the rest of the nation is 69 percent,’ Rivinius said. ‘So the homeownership rate [in California] is lower than (that of) the rest of the country, and if we don’t raise the [GSE’s loan] limit, things will never improve.’

Mr. Rivinius has yet to discern that the reason why the homeownership rate in California is lower than elsewhere is because prices in California are higher than elsewhere. Further, prices are higher in California than elsewhere due in large part to the unusually large number of toxic mortgages in his state. Without those toxic mortgages, prices could not have escalated to the unsustainable heights which they did. And, as with many other areas of the country, prices in California remain out of whack with incomes.

If Congress were to raise the GSE’s loan limits, such a move would pump yet more air into the still-inflated housing bubble, and therefore postpone the inevitable market correction. If Fannie and Freddie can insure and buy more expensive loans, lenders in California, and elsewhere, will find a way to squeeze even more unqualified buyers into those loans. Worse, unlike the situation with the existing loans which are now in default, once the buyers were to have defaulted on the new loans, the federal taxpayer would be obligated to pick up the tab.

Finally, consider one of the hardest hit markets, that of Cleveland’s. The following is an excerpt from an article this week (on CNNMoney.com):

But even the staunchly pro-consumer [Cuyahoga County Treasurer Jim] Rokakis admitted that predatory lending victims are not entirely blameless for their own problems. With times hard, ‘People were looking for a way to make a living,’ he said. ‘There were all these 'Buy real estate with no credit and no down payment deals. The way to wealth was real estate. Speculation took off, and expectations ran wild before they were dashed.’

As the article adds,

According to Mark Seifert, executive director of [Cleveland’s] East Side Organizing Project, which provides foreclosure prevention services, his staff used to look out the window just before groups of troubled home owners were due in to attend counseling sessions. ‘We'd see Escalades, Range Rovers, Cadillacs out in the parking lots,’ he said. [Emphasis added.]

The article adds further:

Now Rokakis's office is dealing with the aftermath. [According to Rokakis,] ‘One guy came in wanting [our office’s] help to save 12 separate properties,’ many of which he bought on speculation, entirely on credit with none of his own cash invested.’

Please join me in informing our representatives in Washington, D.C., including President Bush, that we give an emphatic “thumbs down” to any bailout. We cannot afford to throw good money after bad.

Jim D

November 19, 2007 1:47 PM

On her blog, Mortgage-uber-weenie Tanta pretty much rips up Eavis' reporting - and Tanta is very credible.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.